Compound Interest Investment: Best Investment Options in India

2024-03-29

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Compound interest investment options are one of the smartest ways that you can opt for, regardless of the amount you invest in. The core factor in compound interest is time, and the more time you have, the higher the payoff will be.

Whether investing your hard-earned money or accumulating wealth, compound interest is the best way to pool more capital into your nest egg. But it is not as simple as it sounds; it takes careful planning and time. And if you play your cards right, you can have a suitable sum by the time you have retired to enjoy your golden years. In this blog, we will explore some of the best compound interest investments for you to explore. Keep scrolling to know the details regarding India's best compound interest investment.

Key Takeaways

Compound interest allows investors to earn interest on both their principal and accumulated interest, leading to exponential wealth growth over time. The longer the investment period, the greater the financial benefits.
Investments can be categorised into safe options for stability and aggressive options for higher potential returns with increased risk.
A mix of safe and aggressive investments can help investors achieve financial security while optimising returns.
Effective wealth growth through compound interest requires budgeting, strategic planning, and portfolio diversification, balancing risk and return for long-term financial stability.
The success of compound interest investments depends heavily on the investment horizon. Starting early and staying invested for the long term significantly enhances financial growth and security.

What is Compound Interest?

The interest accumulated on a deposit from both the principal and accumulated interest is called compound interest. In simple words, it is the interest that you earn on interest. You can choose annual, monthly, or even daily compound interest frequencies as per your suitability.

Let's think about compound interest like a snowball. The faster you start saving your finances, the more money in your snowball, and the larger it becomes.

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How Does Compound Interest Work?

Compound interest is the process of earning or accruing interest not only on the principal amount but also on the accumulated interest from previous periods. Unlike simple interest, which is calculated only on the initial amount, compound interest helps investments grow exponentially over time.

The key principle behind compound interest is reinvestment. Each time interest is added to the principal, the total amount increases, and in the next period, interest is calculated on this larger amount. This compounding effect leads to higher returns over extended periods.

Key Factors Affecting Compound Interest:

Principal Amount: The initial investment or deposit
Interest Rate: The percentage at which interest is applied
Compounding Frequency (n): The number of times interest is compounded in a year (e.g., annually, semi-annually, quarterly, or monthly)
Time (t): The duration for which the investment grows
Additional Contributions: Regular deposits can enhance the compounding effect

Formula for Calculating Compound Interest (with Examples)

The standard formula for compound interest is:

A=P(1+n/r)nt

A = Final amount (including interest)
P = Principal amount (initial investment)
r = Annual interest rate (in decimal form)
n = Number of times interest is compounded per year
t = Number of years

Example 1: Simple Calculation

Suppose you invest ₹10,000 in a savings account offering an annual interest rate of 5%, compounded annually for 3 years.

A = 10000* (1+5/100)3

A=10,000*(1.05)3

A=10,000*1.1576

A = ₹11,576

So, after 3 years, the investment grows to ₹11,576, with ₹1,576 earned as interest.

Example 2: More Frequent Compounding

If the same investment is compounded quarterly (4 times a year) instead of annually, the calculation would be:

A = 10,000*(1+ 5/4*100)4*3

A=10,000*(1.0125)12

A=10,000*1.1610

A=₹11,610

Here, due to quarterly compounding, the final amount is ₹11,610, slightly higher than annual compounding.

Equity-Linked Savings Scheme (ELSS)

ELSS is a type of mutual fund that helps you save tax while offering the potential for high returns. It primarily invests in equities and equity-related instruments, making it a great option for long-term wealth creation.

Lock-in Period: ELSS funds have a mandatory lock-in period of three years, which is shorter than other tax-saving investment options.
Tax Benefits: Investments in ELSS qualify for tax deductions under Section 80C of the Income Tax Act, up to ₹1.5 lakh per financial year.
Market-Linked Returns: Since ELSS funds invest in stocks, their returns are subject to market fluctuations, but they generally offer higher returns compared to fixed-income investments.

National Savings Certificate (NSC)

NSC is a fixed-income investment scheme backed by the Government of India. It is a safe and secure option for individuals looking for guaranteed returns with tax benefits.

Guaranteed Returns: NSC offers a fixed interest rate set by the government, making it a stable investment choice.
Tax Benefits: Deposits in NSC qualify for deductions under Section 80C, making it a tax-efficient investment.
Lock-in Period: The investment has a fixed tenure of five years, and the interest earned is reinvested and compounded annually.

Types of Compound Interest Investment Options

Compound interest investments can be classified into two different categories as described below:

Safe Compound Interest Investments: These investments have a higher degree of safety with foreseeable and expected returns. For instance, you can rely on safe compound interest investments even when market fluctuations occur. If you are a low-risk investor who aims for steady returns, then this option is the best option for you.

Aggressive Compound Interest Investments: These investments aim at maximising returns with higher levels of risk. For instance, there is potential for both large gains and, at the same time, chances of significant losses. Aggressive compound investments do not guarantee stability and steady growth. However, offers higher growth for long-term and consistent investors.

Must Read - Passive Investing

Did You Know?

Certain banks provide continuously compounding interest, which regularly adds interest to the principal amount?

Best Compound Interest Investment Options in India

The best compounding interest investments in India include both safe and aggressive investments. Here is the list of compounding investment options in India:

Safe Compounding Investments	Aggressive Compounding Investments
Fixed Deposits	Equity Mutual Funds
Public Provident Fund (PPF)	Equity-Linked Savings Scheme (ELSS)
National Savings Scheme (NSC)	National Pension System (NPS)
Life Insurance Savings Plans	Unit-Linked Insurance Plans (ULIPs) with Equity Fund investment
Debt Mutual Funds
Unit Linked Insurance Plans (ULIPs) with Debt Fund investment

Must Read - How to Invest in NPS?

Fixed Deposit:

A fixed deposit is a type of deposit with a fixed period and interest for a sum of money. Different banks offer varied rates. It can be opened both offline and online. To understand whether you should invest in a fixed deposit, we need to understand its following features:

Fixed Rate of Return: Fixed deposits guarantee the return specified after you have invested your funds. Financial institutions provide interest rates on their website and also have a fixed deposit interest calculator where you can calculate the interest against the sum of money and time.

Tax Limits for Interest Income: If your total interest earnings do not exceed Rs. ₹10,000, tax will not be deducted. This can be beneficial if your deposits are made in small amounts.

Flexible Period: You can decide the period for a fixed deposit at your convenience. However, every bank has its minimum tenure. You can redeem or extend the fixed deposit once the decided period comes to an end.

Availing Loans: You can avail yourself of a loan against the fixed deposit. Generally, the loan can be taken up to an amount of 95% of the total fixed deposit. However, this percentage differs from one bank to another.

Public Provident Funds:

It is a long-term investment option with attractive interest and return rates. Through this saving scheme, you can make sure to have a sufficient amount of money for retirement. Following are the features of PPF in brief:

Period: The PPF that you take must be for at least 15 years. After 15 years, you can extend it every 5 year.
Investment Amount: For opening a PPF account, you need a minimum deposit of ₹500 and a maximum of ₹1,50,000. You can make the entire payment in one go or pay small amounts in 12 instalments.
Deposit Amount and Modes: You have to deposit at least once in your PPF account in 15 years. This deposit can be made through cheques, cash, or even online. The minimum annual investment can be ₹6000.
Risk: PPF schemes are provided and backed by the government. This offers a guarantee and safety for your deposits.

Life Insurance Saving Plans:

Life insurance savings plans are safe long-term investments that offer guaranteed returns. For instance, iSelect Guaranteed Future from Canara HSBC Life Insurance offers the following benefits:

Guaranteed Returns: Maturity proceeds are guaranteed and predefined. You can contribute for the entire policy period or for a limited time at your convenience.

Recommended Reading: Guaranteed Assured Income Plan

Bonus Additions: Investing for the long term allows you to receive free bonus additions which enhances your fund value in the plan.

Regular Income Option: In iSelect Guaranteed Future Plan, you have the option to start receiving a regular income once you turn 60. This is a survival benefit and does not affect your life cover.

Debt Mutual Funds:

These are the best compound interest investments in India where the amount is invested in securities with fixed income. Such securities include treasury bills, commercial papers, corporate bonds, and certificates of deposits. The following are features of such funds:

Lower Risk Levels: Debt funds are invested in securities whose rate of return and maturity value are already known to you. This ensures less risk and a steady return.
Period: The period of such funds is very flexible and varies from just one day to years, depending on the type of fixed securities.

Credit Quality: Based on credit, all the securities are rated. The fixed income securities are backed by the government and are a secure option.

Unit Linked Insurance Plans with Debt Funds:

ULIP refers to the combination of insurance and investment plans. In simple words, the premium amount you pay is partly used for insurance and partly for investment in debt. These debt funds include debentures, government bonds, securities, and corporate bonds. The following are the features of ULIP with debt funds:

Risks Associated: These kinds of mutual funds come with medium to low risks.

Shifting Funds: If you see too many fluctuations in the market, you can change from one fund to another.

Tax-Savings: You can enjoy the benefit of tax savings as premiums paid towards ULIP are tax deductible up to ₹1,50,000 as per the Income Tax Act, 1961 Section 80C.

Withdrawal: During emergencies, you can withdraw funds once the lock-in period has ended.

National Pension Scheme:

It is one of the best compound interest investments where your savings are pooled from time to time in one fund, which is invested based on guidelines in numerous portfolios, including government bonds, debentures, and shares.

Voluntary: The scheme can be opted by Indian citizens between the ages of 18-65 years who are in the working sector.

Flexible: From ₹500-1000 per annum, you can continue the account even with low and flexible investment amounts.

Independence: This scheme is a means of ensuring financial independence for you after you retire.

Secured Option: Since it is regulated by the government of India, it is a safe source of investment.

Equity Mutual Funds:

In these funds, your finances are invested in stocks of different companies. These are also called growth funds. It is beneficial for you since it has higher returns than both FDs and debt funds. Following are the features of Equity Mutual Funds:

Risk: There is a high risk associated with it as it is dependent on the market conditions and performance of the company.

Tax Savings: You can save tax as equity mutual funds schemes allow you to claim tax under 80C.

Diversified Portfolio: You can invest small amounts in equity mutual funds, make a profit, and have different stocks in your portfolio.

ULIP with Equity Funds:

Like other ULIPs, it is a combination of both insurance and investment. In this category, the investment is riskier since it is associated with fluctuations in the market. The following are its features:

Easy Switching: In such plans, you can easily switch your funds from debt to equity and equity to debt as per your suitability and market conditions.

Risk: High risk is associated with higher returns. Therefore, you should opt for this plan only if you have a greater appetite for risk.

Transparency: All charges with such plans are clearly shown to you. These include charges for allocation and fund management.

Investment Term & Tax Savings: With plans from Canara HSBC Life Insurance, you can invest in plans up to 99 years of age. With a limited pay option, you can build your retirement corpus till the age of 60 and then draw a tax-free pension until the corpus lasts.

Also Read - Defined Benefit Pension Plan

The switching option lets you switch your corpus from equity funds to debt anytime.

Features of Compound Interest Investment Options

Compound interest investments are designed to grow wealth exponentially by reinvesting earned interest over time. Some key features include:

Compounding Frequency: Interest can be compounded daily, monthly, quarterly, or annually. The more frequent the compounding, the faster the investment grows.
Principal Growth: Unlike simple interest, where interest is calculated only on the initial amount, compound interest grows both the principal and accumulated interest, leading to higher returns.
Time as a Growth Factor: The longer you stay invested, the greater the compounding effect. Even small investments can result in substantial returns over time.
Interest Rate Variability: Different investment options offer varying rates of interest, and higher rates can significantly enhance returns. Fixed deposits, mutual funds, and certain bonds utilise compound interest structures.
Risk and Stability: Some compound interest investments, like fixed deposits and bonds, offer stability, while others, such as mutual funds, may involve market-related risks.
Tax Implications: Certain investments may be tax-exempt or offer deductions, while others may be subject to capital gains tax upon withdrawal.

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Advantages of Compound Interest Investments

Investing in compound interest options comes with multiple benefits that make them attractive for long-term wealth creation:

Accelerated Wealth Growth: Compounding ensures that earnings generate additional returns, leading to faster wealth accumulation.
Encourages Long-Term Investing: The longer funds remain invested, the greater the impact of compounding, promoting disciplined financial habits.
Suitable for Various Goals: Compound interest investments are ideal for retirement savings, children’s education funds, or wealth preservation strategies.
Passive Wealth Generation: Once invested, money continues to grow without requiring active intervention.
Low Initial Investment Requirement: Many compound interest investments allow individuals to start with small amounts and build wealth gradually.
Diversification Potential: A mix of compound interest instruments, such as bonds, stocks, and mutual funds, helps spread risk while maximising returns.

Disadvantages of Compound Interest Investments

While compound interest investments offer significant advantages, they also come with potential downsides:

Longer Maturity Periods: The real benefits of compounding are seen over extended periods, making it unsuitable for short-term financial goals.
Market Risks (in Some Cases): Investments in equities and mutual funds that utilise compound interest strategies can be subject to market fluctuations.
Tax Liabilities: Interest earnings may be taxed, reducing the overall returns if not placed in tax-efficient investment vehicles.
Inflation Impact: If the compound interest rate is lower than the inflation rate, the real value of returns may diminish over time.
Limited Liquidity: Some compound interest investments, such as fixed deposits and long-term bonds, may impose penalties for early withdrawals.
Requires Patience: Compounding works best when left undisturbed for long durations, requiring patience and a long-term perspective.

Final Thoughts

Four keys to effective compounding are- budgeting, planning, investing, and diversifying your portfolio for the best compounding effect of your wealth. Diversification of the portfolio by including both safe and aggressive compound interest investments for minimising overall risk combined with adequate financial planning can be the ideal strategy for your finances.

However, it is vital to keep in mind that compounding will not take place effectively without having a proper time horizon. If you can do this over time, you will probably see your wealth growing, which will, in turn, map your way to financial freedom.

Glossary:

Accumulated Interest: The total interest earned over time on an investment or loan.
Equity-Linked Savings Scheme (ELSS): It is a mutual fund that focuses on investing in equity markets and offers tax benefits under Section 80C of the Income Tax Act.
National Savings Scheme (NSC): A government-sponsored scheme promoting small savings among individuals. This scheme provides fixed returns over a specified period.
Treasury Bills are short-term debt instruments issued by the government for less than one year to raise funds. They typically offer low-risk investment options.

FAQ’s Related to Compound Interest Investments

The best compound interest investments typically include long-term options like mutual funds, stocks, or retirement accounts, where earnings are reinvested to generate exponential growth over time.

Common compound interest growth accounts include Certificates of Deposit (CDs), savings accounts, and money market accounts. Additionally, you can enjoy the benefit of compounding by reinvesting interest or dividends earned from bonds, stocks, and real estate investment trusts (REITs).

Equities or stocks offer the potential for the highest returns in India, albeit with higher risk compared to other investment options.

Typically, fixed deposits with a duration of 6 months or less accrue interest at a simple rate, while those exceeding six months undergo compounding. Banks often apply discounted rates when calculating interest for monthly payout options.

Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.